I’m a Tax Professional: How To Make Your Smaller Refund Work for You
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Angela Mae
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Molly Sullivan
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According to early IRS data, the average tax refund is 29% smaller this year at just $1,395 vs. $1,963 last year. While this statistic could still change in the next couple months, the smaller tax refund doesn’t bode well for those hoping for a larger amount.
For many people, receiving a large check in the mail from the IRS is how they make ends meet, pay down debts or build up their savings. So, when the numbers indicate a much smaller amount, it’s unsurprising that taxpayers aren’t sure what to do.
GOBankingRates spoke with two tax professionals, Crystal Stranger and Dana Ronald, about what to do if you get a smaller refund and how to make it work in your favor. Here’s what they suggested.
Reassess and Start Planning
No matter what size refund you get, one of the most important things you can do is review your financial situation. Does your budget need to be adjusted? Do you need to increase your income to make ends meet or so that you have extra cash for short- and long-term goals?
“As a tax professional with over 40 years of experience, I have seen many individuals receive smaller tax refunds than expected,” said Dana Ronald, a tax professional and president of Tax Crisis Institute. “In these situations, it’s important to make wise financial decisions to maximize the impact of your refund.”
Review your finances, budget and goals. Make any necessary changes and start planning based on what you want and need. This could mean putting the refund into a high-yield savings account (HYSA) where it can accrue interest. Or it could mean paying down high-interest debt.
“It’s important to use this as an opportunity to reassess your finances and make any necessary adjustments,” Ronald said.
That way, you can make your refund — regardless of how small it is — work for you.
Pay Off Debt
The average American consumer owes around $6,000 in credit card debt. While an average tax refund of $1,395 won’t be enough to get rid of that debt, it can take a big chunk out of it.
“Pay off high-interest debt,” Ronald said. “If you have credit card debt or any other type of high-interest debt, using your refund to pay it off can save you a significant amount of money in the long run.”
The average credit card interest rate is 21.47%. Depending on how much you owe on yours, you could be spending hundreds or thousands of dollars in interest before you pay off your balance. By applying your tax refund to any existing high-interest debts, you could save yourself money in the long run.
Start Contributing to an Emergency Fund
An emergency fund can help keep you afloat during times of financial trouble. But while most experts suggest having at least three to six months’ worth of living expenses set aside for emergencies, many people don’t have nearly that amount.
If you don’t have much of a financial cushion against unexpected expenses, your tax refund could help.
“Save for emergencies,” Ronald said. “It’s always a good idea to have some savings set aside for unexpected expenses. Consider putting your refund into a high-yield savings account so that it can grow over time and be available when you need it.”
Use a High-Yield Savings Account
“In the short-term, many taxpayers rely on their refund as a savings account to catch up on bills or make a big purchase,” said Crystal Stranger, JD, EA, NTPI Fellow, and CEO of Optic Tax.
But rather than stashing the cash in a traditional savings account, consider using a HYSA. This is a type of account that has a higher interest rate — or yield — than traditional savings accounts. In lieu of investing, it can be a great place to start saving money or building an emergency fund.
“Having a refund for most taxpayers is like giving an interest-free loan to the government for the year,” Stranger said. “When interest rates were super low, it probably didn’t make much difference, but now that you can get 5% savings account rates, it makes more business sense to have a savings account regularly contributed to and minimize your refund.”
Invest In Yourself
You might not immediately think about investing in yourself, but doing so can go a long way toward setting you on a lucrative financial path.
“Use your refund to invest in your education or career advancement,” Ronald said. “You could take a course, attend a conference, or purchase equipment that will help you improve your skills and increase your earning potential.”
Many online courses are inexpensive or even free, so your small tax refund could go a long way toward improving your education or professional prospects.
Start Saving For Retirement
The sooner you can start saving for retirement, the better prepared you’ll be when the time comes.
“If you have an IRA or 401(k), consider using your refund to contribute,” Ronald said. “This will not only help you save for retirement but also reduce your taxable income for the year.”
If your taxable income drops, next year’s tax bill will also decrease. You might also become eligible for certain tax deductions or credits, which can help your financial situation down the line.
Refrain From Splurging
Splurging every now and then isn’t necessarily a bad thing. But when you’re struggling to get by, it’s the last thing you should do.
“Remember, your tax refund is not free money. It’s simply a return of the excess taxes you paid throughout the year,” Ronald said.
Instead of viewing it as extra cash to spend, he suggested avoiding unnecessary or large purchases — at least until you’ve addressed any underlying financial issues and improved your overall financial situation.
Look Into Tax Credits and Your Withholding Amounts
Tax legislation changes frequently, so be sure to brush up on any tax credits or deductions you might qualify for — this could help lower your tax burden or get you a larger refund next year. And don’t forget to review your yearly tax withholdings.
“As many tax credits and deductions phase out at higher income levels, if someone receives a raise, then they often will end up in a higher effective tax bracket,” Stranger said. “Reduced withholding can impact the amount of a refund.
“I noticed last year that many employers were pushing harder than before for forms W-4 to be updated each year,” she continued. “This allows for a more accurate withholding amount, leaving the refund amount minimal as less tax is withheld each month.”
Keep in mind that having a smaller refund isn’t necessarily a bad thing. After all, it means you haven’t overpaid the IRS in taxes throughout the year.
Your refund might not be much, but your monthly income will be higher as a result. And that means you’ll have more money when you need it during the year, rather than having to wait until you file taxes.
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